It's a fact of life: Market values change. As portfolios suffer from volatility, the traditional tools are recommended:
1) Target date funds -- designed to manage inherent risks based upon age.
2) Stock to bond ratio theory -- 100 less your age equals the amount that should be allocated to stocks; the difference in bonds.
3) Laddered bond portfolio -- limited durations of bonds arranged to an assumed life expectancy.
4) Asset allocation -- individual stocks managed according to levels of risk tolerance based upon historical returns.
5) Housing values -- always known as the fall back asset of last resort.
These are but a few of the models followed by professionals. Each of these tools come with degrees of inherent risk. In every instance, success achieve a secure income is dependent upon external forces. In no instance are these facets of risk equal due to individualized needs.
As Will Rogers purportedly quipped, "I'm more concerned about the return of my money than return on my money."
Indeed, this wisdom is somewhat relevant today as even now, fraud and greed appear to be ever-present and on a scale larger than could have been imagined.
Simple things like SPIAs don't garner headlines. They are not fast-paced and they aren't traded. Those in retirement with leisure time and savvy skills may day trade their way to higher portfolio values and eventual income. Even selling assets to convert them to cash for income is still a bit risky.
Target date funds
These plans purport to make specific amounts available on future dates. The dates are known in advance, and assumptions are made about how much to allocate into stocks versus bonds. Further risk parameters might lead to additional fine-tuning to reach a particular objective. The difficulty for these funds is when performance assumptions are not realized. Targets are missed. Shortfalls may occur. Such is life.
Stock and bond ratio theory
In this model, one's age is subtracted from 100. For a 65-year-old, the resulting number would be 35. This model suggests that 35 percent of assets be invested in stocks with 65 percent invested in bonds. This might seem to work well over time in a number of instances, the only issue is volatility. The result can be a decimated portfolio. Last year, credit spreads widened so far that corporate bond prices collapsed in a major flight during the liquidity crunch. If 65 percent were invested in bonds, portfolios would have suffered greatly unless invested in U. S. Treasuries. There is usually an alternative.
Laddered bond portfolio
This accepted approach can be part of an asset allocation plan and could be intertwined with the "ageless 100" theory. Indeed, bonds make a great deal of sense. The only difficulty is, well, the timing. Laddered bonds produce income relative to the interest rates at the date of implementation. Like many plans, timing is everything. So, planners who utilize laddered bonds are faced with the dilemma that if a retirement income plan were based upon a 6 percent interest rate assumption, it cannot hold today without taking greater risks -- or without 33 percent to 50 percent more retirement capital than planned. The reason for this is that most laddered bond portfolios are expected to be invested into highly liquid zero coupon US treasuries. No shortage of these at 3 percent to 4 percent.
Now, for a reality check: If a client retires today having based their plan on such a theory, I dare say there is a chance that it may not have worked. Unfortunately, the culprit, once again, is timing. There is no way to predict market forces and values at an exact point in time: your retirement date. Advisors and planners strive to educate and inform clients of the need to manage risks and portfolios. Reducing risks increases probabilities for success. Many such plans have worked well. Some are successful due to just the good fortune. As the saying goes, "I'd rather be lucky than good." Sounds like a plan in need of an upgrade to the real world.
The house as retirement nest egg
I think this idea pretty well has gone out the door for many. In addition to up-sizing or maxing out the size and leverage of home ownership, owners made extensive use of easy credit terms in the belief that home values will continue to grow endlessly. It just isn't so. Compare this to the "sage from Omaha." Warren Buffett still lives in a modest house. Granted, his portfolio is quite healthy, but then, he knows how to invest.
What's the point?
SPIAs provide retirement security. All retirement income plans have common principles:
1) Prudent use of capital
2) Fundamental needs assessments
3) Examination of resources of income
5) Needs versus wants
6) Setting basic objectives
7) Deployment of capital to achieve those objectives
A SPIA is a workhorse. In each of the plans above, the SPIA has both components of risk and opportunity. Here is how SPIAs stack up in the aggregate against the other approaches. SPIAs are:
- Target date plans with a bonus: guaranteed dollars on dates and it pays for life.
- Age 100 plans with a bonus: it replaces the bond component, it pays for life and it allows the stock component to remain higher (i.e., 35 percent or more)
- Laddered bond portfolio with a bonus: it keeps paying for life
- Part of an asset allocation plan that replaces the bond portfolio component with a bonus: it pays for life
- Systematic withdrawal plan with a bonus: it keeps paying for life
- Can't replace a house; but the house can be converted to cash and if the house has fallen in value, then the SPIA can at least pay a high cash flow
A lifetime SPIA can does many things well. Indeed, SPIAs may do them better than many other methods. Life based SPIAs deliver checks every month. They can be purchased at optimum times, such as when interest rates are higher. SPIAs are the unsung heroes of the retirement income that meet the needs of consumers.
What have we learned?
SPIAs offer guarantees. Lifetime SPIAs have embedded value. SPIAs won't garner headlines; however, they may provide sleep insurance for many.
Lifetime SPIAs define retirement security in straight-forward terms. Consumes are buying them. Advisors should be selling them.
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